Lax Law Enforcement Means MF Global Mistakes Will Be Repeated

If you’re looking for lessons on risky business and recidivism, MF Global has them in spades.

Plenty has been written about Jon Corzine’s chronic habit of begging for forgiveness rather than asking for permission when taking outsized trading positions that ended in big losses. The financial services industry allows it if you wear your failure as a badge of honor and never apologize.

Jon Corzine, J. Christopher Flowers, and the rest of the MF Global gang have not yet been called to account for the disappearance of hundreds of millions of dollars.

Some media are nervous about putting boldfaced names of industry veterans like Corzine and MF Global investor Chris Flowers next to details about the missing $600 million in customer assets. They push an innocuous version of why the millions still haven’t been found — it’s a timing problem or there’s too much confusion and complexity — in spite of so much evidence now to the contrary.

For example, the CFTC told the bankruptcy court that the MF General Counsel emailed them hours after the bankruptcy filing on October 31 to say there was a "significant shortfall" in customer segregated funds. The SEC and CFTC issued a joint statement on November 1 characterizing the problem as “possible deficiencies in customer futures segregated accounts.” CME Group issued a statement on November 2 saying, “the firm made subsequent transfers of customer segregated funds in a manner that may have been designed to avoid detection.”

Bad behavior at MF Global long preceded Jon Corzine.

The MF Global 2009 proxy statement describes how investor Chris Flowers was instrumental in pushing, via a board seat for his lieutenant David Schamis, a bold, aggressive, new strategy for the “sleepy” futures clearing merchant. Flowers brought Corzine to MF Global in 2010 to sex up the place, cut costs, and make bets that would turn around three years of losses and allow him to recoup the investment he made to save the firm after an out of control wheat trader cost it $141 million in 2008.

MF Global, the brokerage firm that collapsed Oct. 31 after admitting that more than $600 million in client assets were missing, has a checkered past.

Bad acts go back to its roots as Refco, a Chicago futures brokerage that collapsed and filed bankruptcy in late 2005. After Man Financial spent $323 million to acquire Refco’s client assets and accounts following the bankruptcy, the Refco team was thrown in with the rest of the recent Man Group brokerage acquisitions until 2007. That’s when Man Financial spun off the brokerage business in an IPO and renamed it MF Global.

The U.S. Department of Justice accused Refco executive officers Phillip Bennett, Tone Grant, Santo Maggio, and Robert Trosten, and other former Refco insiders of directing a series of transactions every year from 1999 through 2005 (and quarterly starting in 2004) to hide customer trading losses, conceal the firm's proprietary trading activities, fraudulently shift expenses off Refco’s books and artificially pad Refco's revenues. The Refco executives’ objective was to achieve, through fraud, the 2004 leveraged buyout of Refco and the 2005 initial public offering of Refco stock, the Justice Department said.

When the U.S. Attorney for the Southern District of New York, Preet Bharara, announced the Refco enforcement actions in May of 2010 he spoke earnestly:  "More than just prosecuting criminals who engage in fraud, this Office strives to return as much as possible to their victims.  Justice has been rightly served for the victims of the Refco fraud.”

By that time, what was left of Refco post-fraud and post-bankruptcy had joined with Man Financial to become MF Global via a new IPO.

Bennett, Grant, Maggio, and Trosten faced criminal charges and all four are serving, or will serve, jail terms. Other Refco insiders, including Stephen Grady, Dennis Klejna, and Joseph Murphy, were not criminally charged but signed consent orders, or settlements, with the Department of Justice. Grady, Klenja, and Murphy paid $1 million, $1.25 million, and $5 million respectively. Grady and Klenja then went back to work for the firm that became MF Global.

Not only did those three executives get to come back, they took on roles that gave them a bird's-eye view of MF Global's implosion – and, perhaps, of the transactions that were made, legitimately or not, in an ultimately futile attempt to keep the firm alive as it sought a buyer in the last days.

Dennis Klejna was the head of compliance at Refco when it exploded. Refco had recruited him from the CFTC, the regulator now in charge of investigating the MF Global collapse, where he was Chief of Enforcement. Klejna is now MF Global's head of compliance and senior vice president for legal matters. Operating under bankruptcy protection must be keeping him especially busy these days.

Stephen Grady moved from Refco to Man Financial after Refco’s bankruptcy and is CEO of MF Global Chicago.

Joseph Murphy joined R.J. O’Brien in November of 2008 after six years at Refco, where he served as President of Refco Futures. R.J. O’Brien is one of the brokerage firms that received some MF Global customer accounts from regulators after the bankruptcy.

Since approximately $600 million in customer assets are still missing - I think they are long gone - many have asked me why no MF Global officers or directors have been arrested. It’s less than two weeks since the bankruptcy, so it may be too soon for handcuffs, but customers are very angry.

“Go to their homes, slap the handcuffs on, and force them to sit in Rikers for a while. One of them will squeal about where the money went right away,” said one retired financial services executive who was also a significant MF Global customer.

Some people may be too big to be arrested.

I’ve previously criticized U.S. Attorney Preet Bahara’s reluctance to use the Sarbanes-Oxley Act to bring criminal charges against executives of firms that failed or were bailed out during the financial crisis. Bharara has said in speeches that it’s too hard to prosecute most cases as anything other than perpetrator-free frauds because the “crisis was too complicated for anyone to see it coming.”

Will Bharara also tell us that MF Global’s failure, and the apparent theft of millions in customer assets, is too complicated for the Department of Justice to investigate or prosecute?

The New York Times tells us that Wall Street firms keep promising not to break antifraud laws and then break them over and over again. A recent analysis found that during the past 15 years the S.E.C. brought 51 civil enforcement actions against only 19 different firms. The data expands on earlier excellent columns by Jonathan Weil in Bloomberg.

Judge Jed Rakoff, who has heard many of these S.E.C consent order and settlement requests, is highly skeptical of the S.E.C.’s “no-fault” approach. Rakoff asked in a recent hearing on a settlement with Citigroup if the S.E.C. has ever filed contempt charges against repeat offenders. According to the Times, “the S.E.C. said in a court filing Monday that it had not brought any contempt charges against large financial firms in the last 10 years.”

Judge Rakoff doesn’t like the SEC’s practice of permitting boilerplate language that lets defendants pay a fine “without admitting or denying wrongdoing.” According to his March 21 opinion nixing the agency’s proposed settlement of accounting manipulation charges against Vitesse Semiconductor, “the defendant is free to proclaim that he has never remotely admitted the terrible wrongs alleged by the S.E.C.; but, by gosh, he had better be careful not to deny them either.”

MF Global was full of executives who kept getting good jobs and stuffing their pockets with millions as customers and employees were losing theirs. How many more times will executives like Corzine be forgiven for ruining others’ fortunes and lives?

Correction: A passage in an earlier version of this story incorrectly stated that Joseph Murphy had worked at MF Global.  

Francine McKenna worked in consulting, professional services, accounting and financial management for more than 25 years. She writes "Accountable," a BankThink column on corporate governance, risk management and the Big Four audit firms and their impact on financial institutions. McKenna also blogs at re: The Auditors.